Spain: The Canary in the European Coal Mine

(Sven Larson is an economist with The Wyoming Liberty Group Think Tank in Cheyenne, Wyoming and often appears as a guest on KGAB’s Morning Zone program with Dave Chaffin and co-hosts the special series, Wyoming Perspectives, on The Morning Zone each Friday at 8:00AM MDT along with Wyoming legislator, Amy Edmonds.)

By Sven Larson

~~~~~08/30/2012~~~~~

The resistance to more austerity is growing across Europe. From Greece to France to the Netherlands, anti-austerity politicians are turning the political tide away from a destructive combination of tax hikes and spending cuts. But their solution is just as destructive: their idea is to keep raising taxes – in the French case to a ridiculous 75-percent marginal income tax – but to spend even more on entitlements and government projects. In other words, a return to the very policies that brought about the current fiscal disaster in the first place.

Politically, this is even more absurd. The socialists built Europe’s over-spending welfare states; when spending ran out of control and deficits became a real threat to the fiscal survivability of the EU member states, voters handed over power to center-right parties; once in power, the center-right parties tried their best to save the welfare states that had caused the fiscal problems in the first place; but since their rescue method by pure necessity involved austerity, voters think things were better before the fiscal problems began.

Which, superficially, is correct. You are always better off in a car right before it crashes than right after.

Europe’s increasingly destructive spiral of socialist welfare spending and conservative austerity is painfully visible in Spain. The Iberian nation is being torn between harsh austerity measures, put into place to supposedly save the country from a Greek disaster, and a determined counter-reaction from left-leaning local politicians and activists. The Spanish trajectory, so to speak, is worrisome and tells us a great deal about where Europe is heading. In a matter of speaking, Spain is the canary in the European coal mine.

Spain has announced a drastic series of spending cuts and tax increases in the face of an ultimatum by the EU, as the country struggles to reduce its deficit while negotiating a bailout for its banks. “These are not pleasant measures but they are necessary,” Prime Minister Mariano Rajoy told parliament referring to a programme designed to bring in €65 billon in savings by the end of 2014. “We have very little room to choose. I pledged to cut taxes and now I’m raising them. But the circumstances have changed and I have to adapt to them,” he addded, according to Bloomberg.

If he had chosen tax cuts, he would have given the economy a chance of a moderate recovery. If he had also chosen tax cuts and structural reforms to eliminate the welfare state, he would have given his country a new, prosperous future. But this libertarian “third option” to the socialist spend-and-tax strategy and the conservative cut-and-tax austerity alternative, is not on the political radar screen in Europe.

So what was in the Spanish July austerity package, and what were they trying to accomplish?

The measures include a hike in valued added tax from 18 to 21 percent, a reduction in unemployment benefits and a reform of the public administration. The move is an attempt by Madrid to reassure markets and bring its borrowing rates down to more sustainable levels. It is also part of a quid pro quo deal with its eurozone partners, which have given it an extra year to bring to [sic] its deficit to below the three percent of GDP required by EU rules. It is expected to reduce its budget to 6.3 percent this year, to 4.5 percent in 2013 and to 2.8 percent a year later. “This is a challenging but achievable objective,” said EU monetary affairs commissioner Olli Rehn said at the beginning of the week, while noting that Madrid will have to commit to the “rapid adoption of additional measures.”

Mr. Rehn is wrong. The combination of higher taxes and lower government spending is going to make it harder for the Spanish government to close the deficit gap. This austerity strategy:

shrinks the tax base when higher taxes reduce consumer spending and force more layoffs in the private sector; and

increases demand for government-provided entitlements when more people are unemployed and poor.

Not only is austerity a self-defeating proposal, but if pushed far enough it puts social and economic stability in jeopardy, something that the EU Observer noted already in July:

The new cuts have caused anger among many of Spain’s citizens, with the country already suffering from a high unemployment rate, particularly among its youth. On Wednesday, thousands of miners made their way to Madrid to protest the government. They were joined in the Spanish capital by anti-austerity demonstrators.

An escalating dispute between Madrid and Spain’s regional authorities risks undoing its austerity pledge to EU authorities. The conflict erupted on Tuesday (31 July) when Jose Antonio Grinan, the President of the Andalucia region, walked out of a meeting of Madrid’s Council of Fiscal and Financial Policy when it told him to cut another €3 billion from his 2012 budget. Catalonia boycotted the meeting in the first place, saying it already cannot pay some hospital, child-care and elderly-care centre workers.

There are still those who deny that austerity is taking place in Europe. Then there are those who think it is desirable to import this to America. Fortunately, there is a third alternative, as mentioned earlier. More on that later; back now to the rising tensions in Spain:

Asturias and the Canary Islands voted against the council’s demands. The Basque region also raised heckles. Regional spending was the main reason why Spain last year missed its deficit targets under EU rules: Andalucia and Catalonia between them have a GDP of €346 billion, or 32 percent of the country’s total economy. Andalucia’s Grinan renewed his attack on the government on Wednesday. He said at a press conference in Seville, the Andalucian capital, that he would challenge Madrid’s demands in Spain’s Constitutional Court if need be.

This mans is a socialist, a fact worth keeping in mind:

The Socialist also fired a political broadside against conservative Prime Minister Mariano Rajoy. “This … could close 19 hospitals, all of the Andalucian health service, or get rid of 60,000 public workers, one in four of the local governments workforce,” he said at the press event, according to local news agency Europa Press. “We are taking resources away from health care and education to save the banks, that is intolerable.”

This is the same kind of ideological mantra that carried the French socialists to both presidential and parliamentary victories this summer. The Dutch socialists are also beating the “unfairness” drum, but more in the traditional sense of income redistribution and having government give things to people for free.

As the national government has continued to push through its austerity package, resistance among the general public has only grown stronger. The situation is in fact getting desperate, to a point where the Spanish prime minister is now – predictably – finding himself in the same situation where his Greek colleague was before the May parliamentary election:

Spanish Prime Minister Mariano Rajoy on Tuesday (28 August) said his government has not yet taken a decision on asking for European help in refinancing its debt, pending a key meeting of the European Central Bank next week. Speaking alongside EU council chief Herman Van Rompuy, who interrupted his vacation in Spain to meet the Prime Minister, Rajoy re-stated his commitment to “take all necessary measures” to get the country out of the worsening crisis. “We’ve already taken complicated, painful decisions, but they were required in this situation. We have to lower our public deficit, we can no longer continue in this situation where refinancing is so difficult,” he said. Fresh data published on Tuesday by the country’s statistics office showed that recession is now at 1.3 percent of GDP, compared to previous estimates that suggested the economy would contract by one percent.

Austerity is working. Higher taxes are depressing private-sector spending; government spending cuts are depressing government spending.

You don’t need to have a Ph.D. in economics to see that this is going in the wrong direction. But you probably have to have an appreciation for Keynesian macroeconomics.

On the same day, the country’s most economically important region, Catalonia, said it would need a €5 billion bailout from the central government to refinance its debt. Rajoy brushed off questions about the sustainability of the country’s public finances and said Catalonia was not the first region to be bailed out. Yet the worsening data and the soaring borrowing costs for both the central and the regional governments have fuelled speculation that Spain will need a bigger bailout, on top of the €100bn earmarked for its troubled banks.

To misquote Yogi Bera, it’s the Greek deja vu all over again.

Nothing says Spain is going to come out of its current round of austerity measures in any better shape than Greece, where authoritarian or totalitarian political parties captured 40 percent of the votes in the second election round in June. Spain could easily go the same way. While socialist madmen like this small-town mayoral crazeball are still an exception, it is very important to keep in mind that Spain was a fascist dictatorship for a longer period of time in the 20th century than it was a democracy. Let’s also not forget the country’s recent and very bloody history of terrorism.

More than almost any other country in the euro zone (where austerity pressure is crushingly high) Spain is a catalyst for how far a welfare state can be pushed by austerity, before it breaks. Spain is more than four times larger than Greece and at least in the eyes of Europe’s fiscal and monetary policy makers Madrid runs a stronger and more reliable economy than Athens does. This means that they will give Spain more credit, politically and financially, but it also means that once austerity pushes Spain beyond the breaking point, the turmoil that follows will in all likelihood be of a magnitude not seen in Europe since Weimar Germany.

Now: should anyone be interested in the libertarian alternative between the socialist welfare state and conservative austerity, there is a very important book that I would strongly urge you to read.

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